In general, retirement plans come in two varieties: Defined Benefit plans and Defined Contribution plans. The Defined Benefit plan provides a defined benefit to a participant based on various factors including the participant's age at retirement and years of employment. In contrast, the Defined Contribution plan provides a benefit to a participant based on the total amount of money the participant contributes to the plan and any gains or losses from investing those contributions. Examples of Defined Contribution plans include money purchase plans and 401(k) plans. In recent years, Defined Benefit plans are giving way to Defined Contribution plans because employers would prefer to avoid the earnings volatility associated with Defined Benefits plans.
When Defined Contribution plan participants retire, they often use part of their retirement benefits to purchase an annuity because it provides a guaranteed income stream. In general, annuities are defined by a point of purchase and a point of distribution. The point of purchase is the time at which an annuitant purchases an annuity and the point of distribution is the time at which income payment are begun. One example type of annuity is an immediate annuity. For an immediate annuity, the point of purchase and the point of distribution are the same and the annuitant receives regular income payments for her life similar to the Defined Benefit plan. Another example type of annuity is a deferred annuity. The purchase price for the deferred annuity is typically based on an interest rate and longevity statistics. When the annuitant reaches a pre-specified age (point of distribution), income payments are made to the annuitant for his life. A few employer-sponsored Defined Contribution plans optionally incorporate a deferred annuity feature for those employees desiring a guaranteed income stream at retirement.